Defaulting banks - where will it stop?

[Jan Klimkowski]

For a technical analysis of why FUBAR is imminent, Ticker Forum's Karl Denninger is - as usual - most astute. He's also welcome relief from the drivel MSM continues to feed us:

http://market-ticker.denninger.net/

I repeat: It is time for Congress to lock up the children in their playpen and allow the adults to have a discussion with them regarding solutions to the economic problems we face.

If CONgress fails to do so, you will see The DOW at 5,000 and the S&P 500 at 500 within the next 12-24 months.

Guaranteed.

This morning Bernanke's Fed "decided" to essentially enter the realm of unsecured lending through the creation of a "SPV" (a "SIV", or as I and others have called it, a "SIeVe") that will buy 3-month commercial paper.

While they claim that these borrowings are "secured", the fact remains that in essence they are not, protests to the contrary notwithstanding.

Read that new alphabet soup description carefully, and pay special attention to the rating requirements. It is narrowly targeted - perhaps so narrowly as to permit a very small number of firms to roll their commercial paper.

Academia, including most particularly Bernanke, posits that one must "increase liquidity" into a seizure in the markets such as we have now, lest we have a Depression.

The failure of this so-called economic "theory" is that it fails to recognize the root cause of the problem and therefore misses the forest for the trees. It is akin to trying to put out a forest fire by peeing on it and has precisely the same end result.

In point of fact we are now running out of names for Bernanke's "liquidity facilities"; TAF/PDCF/TSLF/TARP/ABCPMMMF and now this new SPV (does it have a name yet?)

The truth is that this crisis occurred under Greenspan and Bernanke's watch precisely because these two "gentlemen", along with our Treasury Secretary Paulson and other government officials, presided over the granting of credit to people who could not pay it back.

The false premise these folks all proceed from is that credit is equivalent to money.

It is not.

Credit spends like money but it is not money. It is in fact debt and comes with the millstone of interest, which must be repaid along with the principal.

The commercial paper market for non-financial, non-asset-backed entities has not frozen. Nor will it. Those firms have not abused the market and thus have nothing to fear.

It is in fact those firms that have abused this market that have problems, just as occurred with municipalities with "auction-rate" securities.

Borrowing short-term (to lower the coupon required) for long-term requirements is fundamentally unsound. When you do so you place the very life of the entity that does so at risk.

If I am an aircraft manufacturer and require two years to build an airplane, to borrow for less than a two year term in order to fund completion of that airplane for delivery to the customer is idiotic. Yes, doing so means I pay less in interest, but it also means that at any time if the market perceives my firm to be "unsafe" I risk instantaneous bankruptcy of the enterprise.

This is just one more example of how "levering up" has gotten so out of hand, and why we are in this mess in the first place. This particular form of idiocy is not limited to one firm - in fact, it is common across huge parts of the S&P 500 and even many smaller firms, along with state and local governments. It was and is intellectually bankrupt and those who engaged in this behavior should be run out of town on a rail.

"More liquidity" will not solve the problem no matter the form. This has now been proven correct through more than a year's "grand experiment" by Bernanke and friends.

The credit markets, along with consumers and banks, are literally choking on all the liquidity being shoved down their throats. It has done exactly nothing to address the problem and won't because:

* Banks and other financial institutions have been repeatedly proven liars in terms of their financial strength and balance sheets. Pick a financial institution and you will find that almost without exception they have claimed "exposure" to bad debt that is a tiny fraction of what is later shown to be accurate. Nobody can fairly evaluate a firm's financial strength so long as this continues; ergo, nobody can have a reasonable degree of trust to lend to such an institution. In addition even settled black-letter law in some regards has been shown to be wantonly (and perhaps feloniously) ignored; Lehman, as an example, is alleged to have transferred segregated customer funds and securities to a Cayman Islands subsidiary shortly before it went under, effectively locking up funds and securities that are supposed to be safe from a bankruptcy proceeding.
* Consumers are tapped out. The House-cum-ATM machine is empty and cannot be refilled. Consumers will retrench severely, even though they have had to be dragged kicking and screaming into that mode. Nearly 18 months ago I detected the trend in the consumer credit data. This recession cannot resolve until the over-leveraged state of the consumer is rectified. That requires that the bad debt be defaulted and thus cleared. Consumers are more than 2/3rds of the economy.
* It is not possible to reflate the credit bubble. We must deal with the reality that the bad debt in the economy - no matter who holds it - must be defaulted.
* There is no "liquidity trap" into which to fall; we are already in the hole as there is no more capacity to borrow; we have exceeded the maximum safe amount of lending that can be accommodated in the economy. When one is in a hole, the first rule is to stop digging.

Remember, we were told repeatedly that Bernanke's Fed and Treasury's actions would prevent a recession. We were told that the TAF would free up bank lending. We were told that the TSLF and PDCF would prevent more blowups in investment banks after Bear Stearns yet Lehman blew up and the two remaining IBs (after the essentially-forced merger of Merrill) were forced to reorganize as commercial banks to prevent their own implosion.

None of these claims and predictions has proven out.

As this crisis has deepened instead of forcing the liars into the open and shining the bright light of truth upon them, along with arresting and prosecuting the fraudsters, we have instead seen yet more obfuscation and falsehood both explicitly condoned and even perpetrated by the government.

Bernanke's thesis has been proven incorrect.

It is time for Americans to demand that the children, Ivory Tower Savants and those with clear conflicts of interest who are trying to game Congress and regulators to strip hundreds of billions of taxpayer dollars for their own enrichment be locked in their playpen beyond both sight and hearing while adults are admitted to the sacred halls of Congress.